Emily Palmer

• Bankruptcy Solutions
• Foreclosure Solutions
• Modification & Negotiation
• Credit Card Debt Relief

Subchapter 5 is a Lifeline for Small Businesses

On February 19, the Small Business Reorganization Act (SBRA), the most significant change to the Bankruptcy Code in 15 years, went into effect. The SBRA, also known as Subchapter 5 of Chapter 11, removed numerous barriers that had long prevented small businesses from reorganizing in bankruptcy. On March 27, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) went a step further and significantly expanded eligibility under Subchapter 5 by raising the debt limit from $2.7 million to $7.5 million, giving more small businesses access to Subchapter 5’s streamlined procedures. (Kovsky-Apap) The CARES Act is a virtual lifeline to keep small businesses afloat after the tumultuous year of 2020.

This lifeline comes in the form of an appointed trustee to facilitate the development of a plan of reorganization. Subchapter 5 is more streamlined, more affordable, and most importantly, allows the debtor to continue torun the business.Existing management continues to operate the company in bankruptcy as the “debtor-in-possession.” (Kovsky-Apap) Although a trustee is appointed in all small business cases, the trustee’s job is to facilitate the development of a plan of reorganization, not take control of the business. The business owner will need to provide the trustee with tax returns, account information, and financial information, such as assets, liabilities, and cash flows. Instead of a year or longer, the debtor must file a plan within 90 days after the bankruptcy is filed, a status conference is held 60 days after filing, and the debtor must provide a written report regarding the efforts it made to achieve a consensual plan at least 14 days before that conference.

A small-business debtor does not have to convince creditors to vote in favor of his plan as long as the plan commits all disposable income for a period of three to five years to paying off the creditor. The plan must contain a brief history of the debtor’s business operations, a liquidation analysis, and projections showing how the debtor will be able to make the plan payments. Administrative expense claims can be paid over the life of the plan. Even if creditors are not paid in full, existing equity holders can retain ownership of the debtor. This change with the trustee can help with the goals of expanded access for the debtor, but unsure efficiency for the creditors.

Why did the Titanic sink, despite being considered unsinkable? The conventional answer is the design of its watertight compartments was flawed. The ship was designed such that if the first few compartments were flooded, the flooding would be contained by the watertight bulkheads. But the iceberg ripped open a gash almost a third the ship’s length, flooding the first six compartments. As the ship’s bow sank, water poured over the bulkhead into the seventh compartment, and so on, until the ship’s bow sank deep enough to bring the ship almost vertical, at which point the hull broke in half. (Smith)

For creditors, Subchapter 5 decreases their leverage in bankruptcy. In a traditional chapter 11, a creditor could force the debtor to the negotiating table because of a risky plan. With the changes brought by Subchapter 5, creditors will have to find new ways to exert leverage. In Subchapter 5, debtors are permitted to pay creditors through the plan, which means creditors may have to wait up to five years to be paid in full for the bankruptcy case. So far, no bankruptcy court has considered the interaction between the provision of the bankruptcy code that requires debtors to “timely perform” their lease obligations and the provision that allows Subchapter 5 debtors to pay administrative claims over five years. (Feldman) Even if creditors are not paid in full, existing equity holders can retain ownership of the debtor. Either debtors or creditors in Subchapter 5 will benefit from their counsel gaining the support of the appointed trustee. Creditors will need to seek representation as soon as possible after a case is filed through Subchapter 5.

Recently, in response to the COVID-19 pandemic, there has been a trend to weaken landlord protections. For example, in May, the bankruptcy court for the Eastern District of Virginia in the Pier 1 case, allowed the debtor, over the objection of their landlords, to accrue unpaid rent as an administrative claim, notwithstanding the obligation in the bankruptcy code to “timely perform” the obligations under the lease. (Feldman) Similar orders were entered in the Modell’s Sporting Goods, Inc. case (pending in the District of New Jersey) and the CraftWorks Parent, LLC case (pending in Delaware). Both cases were cited by the Court in Pier 1, which recognized that chapter 11 debtors “throughout the nation” were seeking “to find a way to ‘shelter in place’” during the COVID-19 pandemic. In each case, this “sheltering” took the form of avoiding or delaying payments to their landlords. (Feldman)

It remains unclear whether bankruptcy judges’ tolerance of delayed landlord payments in exchange in large cases will also be reflected in smaller chapter 11 cases. But the relief granted in these highly scrutinized cases makes it likely that more and more debtors will seek similar relief, asking courts to delay their obligation to pay landlords in exchange for those landlords receiving an administrative claim.

If a Subchapter 5 debtor can force landlords to accept post-petition rent payments over five years, small-business debtors may have significant leverage against landlords compared to a traditional chapter 11 plan. (Feldman) Landlords could potentially be forced to accept the risk that the debtor is unable to perform the plan. As a result, landlord creditors, in particular, will need to be on guard in Subchapter 5 cases and may need to take steps early in the case to ensure their interests are adequately protected.

In conclusion, In an attempt to make chapter 11 more streamlined and less expensive for debtors, Congress amended the bankruptcy code to add Subchapter 5. Subchapter 5 is available exclusively to small-business debtors and provides a new option that is intended to be quicker and cheaper; it also offers less oversight and fewer reporting requirements than a traditional chapter 11 case. However, these regulations do nothing to address the risks created for the creditor and the real economy. In effect, the idea that the financial system is unsinkable remains intact, even though the flaws in its design (the equivalent of the watertight bulkheads) remain invisible. The system is rushing headlong toward its encounter with the iceberg, while the passengers and crew remain supremely confident and unaware of the risks, risks that will only become apparent after the system has broken in half and sunk to the bottom, destroying most of those who believed it unsinkable.

Works Cited:

Feldman, Odin, and Pittleman PC. “Four Things to Know About the CARES Act and the New Small Business Bankruptcy Reorganization Act.” 16 June 2020. Lexology. https://www.lexology.com/library/detail. Accessed 10 Apr. 2021.

Kovsky-Apap, Deborah, and Hugh M. McDonald. “What Small Businesses Need to Know About Restructuring Under Subchapter V and the CARES Act.” Troutman Pepper. 3 Apr. 2020. https://www.troutman.com/insights. Accessed 10 Apr. 2021.

Smith, Charles Hugh. “The ‘unsinkable’ global financial system is rushing headlong toward an iceberg.”The Daily Reckoning, 16 Mar. 2016. https://www.businessinsider.com/. Accessed 10 Apr. 2021.